International taxation can be conceptualized as the application of the tax system of the United States in an international environment. U.S. taxation extends to two fundamental types of international transaction classes: (1) investments or trade or business of U.S. persons offshore or outside the U.S. (outbound transactions); and (2) investments or trade or business of foreign persons in onshore or in the United States (inbound transactions).
The United States taxes its residents on worldwide income whether or not they reside in the U.S. as long as they are considered U.S. citizens or residents. In contrast, individuals who are neither citizens nor residents of the United States (“nonresident aliens”) are only subject to limited U.S. federal income taxation. The term United States person includes individual citizens and residents of the United States.
Corporations, partnerships, LLC’s and trusts are taxed on worldwide income if they are United States persons. Foreign entities are generally only subject to limited U.S. federal income taxation and it generally does not matter where the entity is managed.
Entities qualify as United States persons as follows:
Corporations qualify as U.S. persons where they are organized in or under the laws of the United States (Federal Law) or of any State (State Law). This rule applies to all associations taxable as corporations, including certain publicly traded partnerships, business trusts and entities electing to be treated as corporations under the “check-the-box” rules.
Partnerships qualify as U.S. persons where they are organized in or under the laws of the United States (Federal Law) or of any State (State Law). This holds true for general and limited partnerships, LLC’s and entities electing to be treated as partnerships under the check-the-box rules.
Trusts qualify as U.S. persons where:
1. Either a U.S. court has jurisdiction to exercise primary supervision over the trust’s administration and one or more United States persons have the authority to control all substantial trust decisions or
2. The trust was treated as a United States person on or before August 19, 1996 and is not a grantor trust and it elected to continue to be treated as a U.S. Person after August 19, 1996.
Estates: There is no useful statutory definition of when an estate becomes subject to U.S. Jurisdiction. The available case law adopts a facts and circumstances test in which the residency of the decedent at death is the most important factor. The residency and location of activities of the trustees, the location of the decedent’s assets and the residency of the decedent’s beneficiaries are lesser weighted factors in the facts and circumstances analysis.
INBOUND AND OUTBOUND TRANSACTIONS
Transactions are broken down into two major types in the international arena 1. inbound and 2 outbound. Inbound transactions include transactions where the United States imposes tax on foreign persons on entities because of nexus with the U.S.. For example, dispositions of U.S. real estate ownership interests by foreign persons or entities are considered inbound transactions and are subject to U.S. taxation because of U.S. nexus over the U.S. real estate. Nexus is defined as a substantial connection between the taxpayer’s activities and the U.S. sufficient for the U.S. to tax the activity.
In an outbound transaction, the U.S. taxes foreign income because of U.S. nexus over the transaction. For example, a U.S. shareholder’s investment in a controlled foreign corporation is an outbound transaction with sufficient nexus so that current taxation may result on certain amounts earned by the foreign corporation whether or not the income earned abroad by the foreign corporation is repatriated to the U.S..
Policy Objectives of U.S. Taxation in the International Arena
The policy objectives underlying U.S. international tax law is designed to promote two basic, and often conflicting, policy objectives.
BRIEF OVERVIEW OF INBOUND TAXATION
Foreign persons are taxed either at the full U.S. graduated tax rates (including a possible additional branch profits tax for foreign corporations) on net income that is deemed to be effectively connected with the carrying on a U.S. trade or business or they are taxed at a flat rate of 30% (unless modified by treaty or the IRC) on the gross amount of their fixed or determinable income that is deemed sourced to United States, but only where such income is not effectively connected with a U.S. trade or business. Certain classes of fixed and determinable income, like most interest income for example, are exempt from U.S. taxation by the internal revenue code for policy reasons.
U.S. international tax law should neither encourage nor discourage investment by U.S. taxpayers within the United States or overseas. The law in this area attempts to ensure that the total tax burden on domestic and overseas investment by a United States person is closely equivalent to what the U.S. tax burden would have been if the taxpayer had chosen to invest solely in the United States.
U.S. international tax law attempts to avoid discriminating between domestic and foreign investors concerning their U.S. tax obligations by attempting to equalize the U.S. tax burden that applies to U.S. investments made by foreign persons and domestic investments made by United States persons.